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Monday, January 12, 2009

Barney Frank Tells People Not to Pay Their Mortgages

A few days back, I made the point that President Obama's policies will soon encourage folks to fall behind on their mortgages. That's because he is so determined to do everything to stem the tide of foreclosures that soon enough he will make the foreclosure process attractive to borrowers. Soon enough, borrowers will find that many will get the best deal through the process of foreclosures. To get a glimpse at just how far these policies will go all you need to do is look at some of the things Barney Frank is proposing.

Wrapping up a week of efforts by legislators and businesses to stake claims on the Troubled Asset Relief Program and the proposed stimulus package, Mr. Frank said he plans to lay out a series of restrictions on the remaining $350 billion in TARP in a bill the House could vote on as soon as next week.

Meanwhile, an industry coalition is lobbying for a tax break that would allow companies to renegotiate troubled debt without incurring corporate income taxes, a potential windfall for many companies, including private-equity firms.

Mr. Frank said his plan would prevent banks from using government money to buy healthy banks and impose tougher executive-compensation restrictions for new recipients of TARP funds. He is also proposing a permanent increase in the Federal Deposit Insurance Corp.'s insurance limit on deposit accounts to $250,000.

This past summer, Barney Frank made a similar proposal in which FHA would guarantee about $350 billion worth of troubled loans. By guaranteeing these loans, FHA would underwrite better rates and terms with troubled borrowers. This particular law went over like a lead zeppelin. That's because Frank couldn't figure out how to make it attractive to the bank holding the current loan. He thought that hundreds of thousands of loans would be guaranteed and less than one hundred were actually done so far.

In this case, Frank wants to use TARP funds to make it easier for banks and borrowers to commit to the process of loan modifications. In this process, a borrower struggling to pay back their mortgage is rewarded with a loan that they can afford. Frank wants to use some of the TARP funds to give tax breaks to any bank that creates a loan modification.

There are a few things to keep in mind. If your only goal is to stop foreclosures, loan modifications are a much better way than encouraging new loans. In loan modifications, the very bank looking to foreclose is the one that does the loan modification. As such, the most motivated entity is the one in a position to act. With his bill last year, a new bank had to take on the loan. Certainly, a new bank isn't nearly as motivated to take on a borrower they know has already been in trouble. Second, this plan is for the TARP funds only. Certainly, no one should believe that Frank will stop with the TARP funds.

I have said over and over that once folks understand the process of loan modifications many will realize that it it in their benefit not to pay their mortgage. Loan modifications start only when someone is behind. Normally, a borrower needs to be two months behind. The deals that borrowers get are better than any market rate they would get. The normal rate for a loan modification is five percent. One loan modification I have seen received a rate of 4% for five years 6% for the next two years and 6.75% for the remaining 23 years. In another case, a borrower received a loan modification with a rate of 1%.

Clearly, for most borrowers, a loan modification is the best option. So, once borrowers find out it is an option they will do everything they can to qualify. Of course, borrowers must be in trouble of paying their mortgages. So, the first thing they need to do is fall behind. The more folks like Frank encourage loan modifications the more they encourage folks to fall behind on their own mortgages in order to take advantage of the process. The TARP funds are only the beginning. Soon the entire federal government, with Frank leading the way, will be doing everything they can to encourage loan modifications. Since you can only be considered for one when you are behind on your own mortgages, folks like Frank will also be encouraging that folks fall behind on their mortgage as well.

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